Monday, March 22, 2010

Economically Damaging and Fiscally Irrelevant

On the Progressive Economy blog, Michael Burke and Michael Taft have a fine post with the above title.  They provide an analysis of the effect of the combined expenditure cuts announced in last April’s Supplemental Budget and the 2010 Budget from last December.

As an analysis of the impact of the ‘cuts’ the piece is excellent.  They use the results of the ESRI’s macroeconomic model of the Irish economy published here to estimate the effects of the changes on the economy.  Burke and Taft’s analysis of the public sector pay cuts is based on the results in Table 3 on page 15.  Other cuts in public expenditure are proxied to cuts in public sector employment using the results in Table 7 on page 21.

As an partial equilibrium analysis of the expenditure measures announced the piece is fine, but the author’s push their conclusions to a general equilibrium setting.

We have shown that ‘savings’ are minimal and the impact on GDP severe. And such is the fractional impact on borrowing there is a distinct downside possibility that such cuts will increase the deficit burden. This is reinforced when we note the deflationary impact on the domestic economy is even more severe. Whereas GDP will decline by -3.1 percent by 2014 as a result of the current spending cuts, GNP will decline by -3.8 percent. This is what the TASC letter referred to as ‘a low-growth, high debt future’.

Cuts do not equal savings. Cuts degrade economic activity with only a marginal impact on borrowing. The next time a commentator says ‘we’re borrowing €400 million a week’ as a justification for more spending cuts, they can easily be answered: cutting spending won’t affect that ‘€400 million a week’ and it may only make things worse.

To bring the deficit under control we need another alternative – one based on growth and not deflation.

To see whether the government is running a contractionary policy we can consider just one measure – the size of the budget deficit.

  • Deficit Jan-Feb 2009: (€2,084,760,000)
  • Deficit Jan-Feb 2010: (€2,407,292,000)

In 2009 (before any of the measures covered in Burke and Taft’s analysis were even announced) we ran a budget deficit of just under €2.1 billion for the first two months of the year.  In 2010 (after the measures have been announced and implemented) we ran a budget deficit of over €2.4 billion.  The deficit is increasing.  This is an increase of about €320 million in the gap between what the Exchequer is taking out of the economy (taxation) and what the Exchequer is putting into the economy (expenditure).

A budget that is adding more money to the economy rather than taking it out, does not fit the definition of a contractionary policy I am familiar with.

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